Due Diligence

This post is mostly to myself to remind me (waves!) to not be such a dumbass and do a little more research before buying any individual stock.

I purchased 40 shares of Xyratex (Ticker XRTX) in my Roth IRA on September 3, 2008. It is a company that manufactures external disk drives, parts and components and the machines used in making those drives. Given the explosion of data available online ready for downloading and media being created and uploaded daily from people's digital cameras, iPods and other devices this certainly sounds like a growth industry.

The first thing I did wrong was I bought too many shares. My standard practice is to buy 25 shares of any company the first time out. Then if it drops in price, a minimum of 10%, preferably 20%, I do more research to determine if I should scoop up more shares at a lower cost basis. But I bought 40 shares instead of the normal 25 because I was being greedy.

The second thing I did wrong was to base my purchase decision purely on earnings estimates of the stock. Earnings estimates are helpful when researching a stock, but they are not concrete - they are ESTIMATES and they can change very rapidly. At the time XRTX was expected to earn $1.09 per share this year and $1.77 per share next year - solid earnings growth.

What I also should have done in September was go onto their company website and review their Annual Report for 2008. This would have given me more insight into their business. Where their revenue comes from, how much debt they have, future expansion plans, an overview of their industry and tons and tons of financial data for the past 3-5 years.

Alas, I didn't do that and bought the stock purely based on the earnings estimates for the two upcoming years. As we all know, the economy has tanked and now XRTX is estimated to LOSE $.25 this year and post a profit of.....wait for it.....$.01 next year. As a result the stock, which I bought at $13.85 per share, now trades at just North of $2.00 per share.

The 2009 Annual Report for Xyratex came today in the mail so I gave it a look while eating lunch. If I had bothered to look at the 2008 Report, which I could have accessed for free on the company's website, I never would have purchased the stock. It turns out XRTX got 70% of all its revenue for 2008 from only 3 customers. So if one of those cancels some orders, goes bankrupt or even merges with another company XRTX will probably be screwed. (Ironically, one of XRTX's major customers is another stock that I have owned in the past Western Digital [WDC].) Having a few customers account for the overwhelming majority of a company's revenue is a Major Red Flag with "Don't Buy Me!!!" printed in huge, bold letters on it.

Greed 1, Jon 0.

Mood: Inquisitive.

Movie Quote of the Day:

"Don't take life too seriously, you'll never get out alive." - Van Wilder